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How Crypto Losses Can Lower Your Tax Bill

Crypto and Investment Taxes Individual Taxes
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Updated for tax year 2023.

The value of Bitcoin and other cryptocurrencies has undoubtedly seen better days. But there’s a small silver lining — if you sold crypto at a loss in 2023, you might be able to save on your tax bill with crypto losses this year.

What is the definition of cryptocurrency?

Cryptocurrency differs from traditional currency, like the U.S. dollar, because it doesn’t have any intrinsic value. It is a decentralized currency, meaning it isn’t issued by an authority such as the government but instead distributed by a peer-to-peer network. This allows crypto investors to trade their coins almost instantly without relying on a payment processor as the middleman.

Cryptocurrency generally exists on a blockchain platform — a shared public ledger that records crypto transactions. Its value is highly volatile and depends on various factors, like the supply and demand of a particular digital currency.

How does the IRS define cryptocurrency?

For tax purposes, the IRS defines cryptocurrency as a digital asset and treats it as property, subjecting it to capital gains and losses rules.

What is the difference between capital gains and losses?

A capital gain occurs when you sell a capital asset (like crypto) for a profit. A capital loss occurs when you sell a capital asset for a loss. A capital gain counts as income, which you must report on your income tax return. However, you can use capital losses to offset your income from capital gains.

Capital gains and losses are divided into two categories: long-term and short-term.

  • Short-term capital gains apply to cryptocurrency you held for one year or less before selling. These gains are typically taxed as ordinary income determined by your maximum tax bracket (10-37% depending on your income).
  • Long-term capital gains apply to cryptocurrency you held for more than one year before selling. These types of gains have their own tax rate — 0%, 15%, or 20%, depending on your income level. Because of their lower tax rates, long-term gains are generally more favorable than short-term gains.

Long- and short-term losses work the same way, except instead of profiting and making a gain, you sell or trade your crypto at a loss.

How can cryptocurrency losses lower your tax bill when filing my taxes?

Capital losses can be used to offset your capital gains — and possibly some personal income.

To claim a loss, you’ll need to have triggered a taxable event by selling, trading, or spending your crypto. This makes it a realized loss. You can’t deduct any losses for holding cryptocurrency, even if it has decreased in value.

Once you realize a loss, you can use it to offset any capital gains you may have had. If your losses are more than your gains, you can use the excess losses to offset up to $3,000 of your personal income as well. Any net losses over $3,000 can be rolled into future tax years.

When offsetting your losses, you’ll first use short-term losses to offset short-term gains before long-term gains and long-term losses to offset long-term gains before short-term gains.

What are some ways to calculate cryptocurrency losses on taxes?

Let’s review a few examples of calculating your losses and using them to offset your gains.

Scenario 1: You decided to start investing a couple of years ago. You purchased some stocks, as well as some cryptocurrency — we’ll go with Ethereum. In 2023, you decided to sell some stock for a gain of $2,000. You also sold Ethereum for a loss of $4,000.

Because you held the stocks and crypto for more than one year, they would be long-term gains and losses. In this example, you could use $2,000 to offset your $2,000 gain and the remaining $2,000 to offset your personal income.

Using the same example, let’s say you sold Ethereum for a capital loss of $6,000. You’d still use the first $2,000 to offset your capital gain, then $3,000 to offset your personal income. Since you cannot offset more than $3,000 of your personal income, you could roll over the remaining $1,000 to offset any gains or income on next year’s tax return.

Scenario 2: Last year, you had $2,000 in short-term capital gains and $2,000 in long-term capital gains. You also had a long-term capital loss of $3,000. First, you would use your long-term loss to offset $2,000 of your long-term gain. Then you would use the remaining loss to offset $1,000 of your short-term gain. This leaves you with $1,000 in short-term capital gains that you would need to report as income on your tax return.

Does the wash sale rule apply to crypto?

You may have heard of the wash sale rule, which prohibits taxpayers from selling securities at a loss and repurchasing the same securities within 30 days. This prevents you from selling an investment just to claim a loss and then immediately repurchasing it.

There is currently a loophole for crypto. Since digital currencies are not currently classified as securities by the IRS, the wash sale rule does not apply. This makes something like tax-loss harvesting reasonably easy to do for crypto investors. You can technically sell coins that have fallen in value to lock in their loss, then turn right around and buy them back again.

However, legislators have been trying to close this loophole, meaning there may be better strategies to count on in the long run.

What are the consequences of forgetting to report cryptocurrency losses on taxes?

The IRS wants to know about your cryptocurrency gains and losses. Failing to report income from virtual currency can lead to an audit and possible penalties.

You don’t want to forget to report your crypto losses either — if you do, you could be leaving money on the table by missing out on offsetting your gains or other income.

The bottom line

If you’re a crypto trader who had to sell coins at a loss last year, you may be able to leverage your losses to save on your tax bill this year.

There’s no need to be apprehensive about reporting your capital gains income and losses. TaxAct® has the resources you need to help you report your crypto transactions. We’ll help guide you through the process so you can rest easy knowing you’ve reported everything correctly this tax season.

This article is for informational purposes only and not legal or financial advice.
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